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Kay the spark for major investor overhaul?

Today’s release of the Kay review of UK
equity markets and long-term decision making could add further pressure to
recent calls for more transparency on trading and other institutional
investment costs.

The interim report released in February 2012
stressed that the fundamental objectives of rewarding savers through investing
in high performing companies could be more effectively achieved. Professor John
Kay of the London
School of Economics revealed that respondents to the report believe that equity
markets have lost sight of these goals. He observed that the current incentives
for fund management professionals over-emphasise short-term returns over the
long-term outlook that would benefit investors.

One of the
review’s respondents, a large activist fund manager, Hermes, wholly owned by
the BT Pensions Scheme, summed up the issue as follows: “Our belief is that the
regulatory framework for the markets and the structure of those markets has
increasingly moved to favour liquidity and trading activity over long-term
ownership”.

Furthermore,
Hermes noted a dramatic increase in volatility -
between 25% and 65% - has reduced appetite among pension funds for holding
equities. The Hermes report maintains that volatility suits
the agents who operate within the markets, since they can take advantage of
trading activity as markets go both up and down.

The
Kay review was commissioned by Vince Cable, the secretary of state for
business, on 22 June 2011, responding to concerns that short-term incentives
and pressures may be damaging to the way listed companies are owned and managed
and the knock-on implications for investors. Kay was asked to look at whether equity markets are achieving their
core purposes: to enhance the performance of UK companies by facilitating
investment and enabling effective governance and decision making in support of
long-term profitability and growth; and to enable investors to benefit from
this corporate activity in the form of returns from equity investment.

Pension
providers and their suppliers – asset managers and brokers – are already under
pressure. Writing in The Daily Telegraph today Steve Webb, the pensions
minister, warned that under current conditions, a vast proportion of the
population will not have saved enough for retirement, in part for reasons of
cost. “If further measures are needed to clamp down on charges, then we will
not hesitate to take them,” he wrote. Last week, the UK
trade body for asset manager, the Investment Management Association (IMA),
rejected the Labour Party’s claims that opaque costs and transaction fees
associated with fund investment are too high and eating into investor returns.
Instead the IMA argued investors should be provided with improved explanations
of costs and charges.

Kay’s
expected recommendations will include greater control and transparency for
investors on directors’ pay and he may suggest more scrutiny of quarterly
reporting requirement. The economist is also likely to complain that the many
organisations involved in the investment process add to cost and have a
detrimental effect on market efficiency.

Having
commissioned Kay to conduct such a high-profile review, the government will feel
somewhat obliged to act upon his recommendations. Recent precedents suggest he
will be backed by ministers.

In
June 2010, the government established the Independent
Commission on Banking to consider reforms to the UK banking sector to promote
financial stability and competition. Recommendations by Sir John Vickers to
separate retail from investment banking have already largely been accepted by
the coalition and recent developments such as the LIBOR fixing scandal suggest
this support has strengthened further.